Vickers' Banking Reforms: Yay or Nay?

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Sir John Vickers recently unveiled the Independent Banking Commission’s proposed reforms for the United Kingdom’s bloated and dysfunctional banking sector. In the 358-page article, neither the words “ethics” nor “ethical” are mentioned once. Is it any wonder that many have lambasted the report as a “total waste of time”?

The Independent Banking Commission was established by the UK's coalition government in June 2010 as a means of kicking a thorny and divisive issue into the long grass.

At the time, the divisions within the coalition government over what to do about the UK's bloated and dysfunctional banking sector were distracting the government from more important issues such as tackling the deficit. The hope was that by the time the commission delivered its final proposals the economy would have recovered and the clamour for reform would have dissipated. In such a scenario it was hoped that, as with Cruickshank a decade ago, the commission's conclusions could be comfortably ignored, and banks could get back to what they know best -- making money.

But the British government has had no such luck. The economy is still a long way from recovery and we may already have entered a double-dip recession. The European sovereign debt crisis is far from resolved. Not only that, but there is still widespread public outrage about the banking sector and its role in precipitating the worst economic crisis for generations. So the government may end up having to enact the reforms after all.

The proposed reforms have prompted an astonishing range of reactions since they were unveiled at a packed press conference inLondon last Monday.

The commission said that its proposed reforms -- which include ‘ringfencing’ (separating) banks' retail arms from their “casino” investment banking activities, requiring them to bolster capital ratios and introducing some throwaway measures to boost competition -- will cost the banks approximately £4bn to £7bn a year in lost profits. Given that, in a good year, the combined pre-tax profit of Britain's banks exceeded £36bn, this may seem a small price to pay for stability.

Given the severe funding difficulties and share price turbulence that most banks have been experiencing as a result of the continuing sovereign debt crisis, and following special pleading from the banks and their lobbyists, Vickers has given the banks some breathing space by giving them until 2019 to implement the reforms. This time frame has been slammed as ludicrously long by critics of Vickers's proposals, who argue this gives them ample opportunity to water down the proposals.

Even so there are serious misgivings about the Vickers reforms in parts of the City of London. Bloomberg reported City sources as saying that Vickers' reforms would take us back to the 'dark ages', bringing a return to the old-fashioned and expensive “narrow banking” that Britons knew so well in the 1950s. Bloomberg quoted the co-head of KPMG’s regulatory centre of excellence, Jon Pain, saying:

“We are seeing a return to a more simple 1950s style of retail banking, where it is perceived as more of a basic utility with low return on equity for shareholders.”

“[I] regard the recommendations of the ICB as likely to permanently increase the risk of instability within the UK financial services sector, with materially adverse consequences for the broader UK economy.”

Neil Bentley, deputy director-general of the employers’ organization the CBI, said that erecting a ringfence between the retail and investment-banking arms of British banks posed a massive risk for the whole country, since it meant Britain would be "going it alone" and that the proposals risked "damaging businesses and threatening growth.”

Turning point?

Still, others lambasted the ICB for being far too weak, too lily-livered, and captured by banking interests (they say the government has caved into the bankers in much the same way that Labour and Conservative governments used to serially cave in to the trade unions pre-Thatcher). Neal Lawson, chair of Compass, said Vickers should have insisted on a 100%, Glass Steagall-style separation of retail and investment banking, instead of a potentially porous ringfence. He said:

“Instead of recommending the simple and effective step of complete bank separation, the British establishment has bottled it, and the City has won again."

But Vickers, a 53-year-old former Bank of England chief economist, a "reluctant apparatchik", and Warden of All Souls College, Oxford, also has plenty of supporters. They seem optimistic that his package of reforms will, in the long-term, make Britain’s banks safer, less reliant on state handouts in the event of collapse, and more predisposed to serve society and the wider economy, as opposed to prioritizing the interests of their own overpaid executives.

The BBC was, at times, effusive in its praise, giving the impression Vickers had found the silver bullet that would cure the UK of its economic ills (see “Acclaim for banking shake-up plan”). Writing in the Financial Times UK-base academic and author John Kay said:

"Only if traditional retail banking is ringfenced can taxpayer guarantees be limited to personal and business depositors, and government funding of the banking system be directed to the needs of the businesses that create jobs and growth … The principal argument the banks have raised against ringfencing is that the cost of capital to investment banking would be higher if retail deposits and the associated taxpayer guarantee could not be used as collateral for its borrowings. That argument is correct, but more compelling to investment bankers than to depositors or taxpayers. The jobs and growth the bankers claim will be in jeopardy are their own…”

Agreeing with the Daily Mail

My personal view is that the commission's remit was probably too narrow from the start. For political reasons, its brief was only to "look at the structure of banking in the UK" and "consider how to promote financial stability and competition in the sector".

This left some dangerous blind spots. It has, for example, meant that the commission didn't even examine ethical considerations, which is bizarre given that it is becoming increasingly apparent that the crisis was fuelled by widespread malfeasance, "creative" accounting, and seeming fraud in the banking sector. Neither the words “ethics” nor “ethical” are mentioned once in the ICB's 146,000-word, 358-page final report (the words “moral” or “integrity” do make a few appearances, but only in association with the concept of “moral hazard” or to denote “completeness”.)

Maybe the ICB believes that, by preventing banks from gambling depositors’ money on so-called “casino” activities, and by preventing them from abusing the implicit state guarantee to sustain their investment banking arms, the temptation to misbehave will be lessened or removed. To me, this seems wildly optimistic.

I don't normally agree with the Daily Mail, but in this instance I agree with the newspaper's city editor Alex Brummer who says the ICB cannot propose a viable blueprint for the future of the UK banking sector unless a thorough-going inquiry into the reasons for the failures of disastrous banks such as HBOS, Royal Bank of Scotland and Northern Rock is carried out first. So far the politicians have desperately sought to avoid such an inquiry. As Brummer said, the report is “proposing changes without really knowing what went wrong. The process is frankly bonkers.”

The proposals may, in any case, turn out to be a sideshow. If Greece does default on its debts, Vicker's elegantly crafted solution would seem like re-arranging the deckchairs on the Titanic.

By Ian Fraser

Ian Fraser, a journalist since 1988, works on programmes about the banking and financial crisis for the BBC. He writes about business and finance for the Financial Times, the Sunday Times, the Independent on Sunday, the Daily Mail, and the Mail on Sunday. Since 2009, Fraser has been a visiting lecturer in financial journalism at the University of Stirling.

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QFINANCE is a unique collaboration of more than 300 of the world’s leading practitioners and visionaries in finance and financial management, covering key aspects of finance including risk and cash-flow management, operations, macro issues, regulation, auditing, and raising capital.